Introduction

Over past decades, Indian business model has been severely revamped up through the evolution of the digital economy or adoption of digital financial services. For example, the largest cabs collaborator in the world, the UBER does not own any cabs but still have the biggest global accommodation provider, same goes with Airbnb business model, Airbnb does not own any housing facilities still operates at large scale in renting accommodation business.

 The traditional Indian tax rules of India, as well as most of the other countries, were devised based on the business model on which majority of respective nation’s economy operates. However, the paradigm has shifts in the way of conducting businesses with the conventional structures and replaced them with the global business model that operates without needing to establish offices or hiring of significant employees in different countries. These new business models heavily rely on the intellectual property assets, and are typically located in a low-tax jurisdiction and are capable to generate significantly huge revenues across globe through highly engaged remote or digital ‘user participation’ from the domestic market, making it complex to bring them under the domestic taxation radar of the source nation.

Digital Tax: Digital service tax (DST) refers to tax collected on revenue generated by providing digital financial services and has not been defined in any domestic or international law and treaty. It is usually imposed by the source country on the revenue generation by global tech companies in such respective country.

The digitization of the tax function: Now-a-days, organisations are realising the importance of taxation technology and are embracing the same, in order to complying with the new electronic reporting requirements, but at the same time it is also important to leverage the automation and AIs factor to ensure theirs internal taxation functions operates accurately and efficiently.

The digital economy: The focus area under the theme of digitization of financial transactions emphasis on more digitalized business models to makes it increasingly possible for the businesses and the taxpayers to reach markets in their respective jurisdictions, in which they might have relatively little or negligible physical presence which under the existing international taxation rules that allocate taxation rights on the business profits on the basis of their physical presence, this can imply that it is possible for a company that is residing in one state (the Residence State) to generate significant revenues in another state (the Source State) without paying the significant amount of corporation tax in the Source State.

 Importance of digital taxation

As per the Statista results of Q1 2021, India having around 560 million internet users, it is the second-largest online user base in the world after China. Hence, digital business model can be overlooked from the country’s taxation revenue based viewpoint. The rapid adoption, progression and development of the technology enable businesses to carry on their activities with a minimal physical presence. Moreover, the global Covid-19 outbreak have helped even to the traditional businesses to overcome with their hesitation regarding remote operations and compelled them to convert from conventional to the digital or remote models of operations and revenue generation in general.  On transformation to such mass digitisation of business models, the complexities from taxation and regulatory viewpoint have been amplified. 

One of the reports from the Ministry of Electronics and Information Technology (MeitY) indicates that “India can create up to $1 trillion of economic value from the digital economy in 2025”. Further, the Indian taxation system and framework has to be amended accordingly to adopt and to ensure adequate technology in taxation to capitalise the opportunity to be an integral part of the global expansion of the digital economy.

Potential grey areas of the Indian Taxation System

The primary focuses of current taxation regime are on dealing with the taxation of physical business activities and revenue generation from businesses physical operations. As the companies are now-a-days increasingly doing remote business in multiple jurisdictions without having physical appearance within the respective jurisdiction(s).

Moreover, companies having virtual business models are thriving on the digital technology (like internet domains, intellectual assets, algorithms and user data etc.) primarily prefer to have their majority of core functions in a tax haven or low tax country. Some of the companies have their source of revenue generation from online activities and services from the Indian resident taxpayers without having permanent or physical establishment in India. Due to the absence of physical or permanent establishment of such foreign companies and the business leads going back to the tax haven country where they will not be liable to pay any tax in the residence country, the business revenue altogether, will not account for taxation in either of the countries.

For instances, as per one of the Business Standards reports, in FY18, in India, Google total revenue crossed Rs 10,000 crores while Facebook total revenue crossed Rs 521 crores. However, 200 crores in total were paid by the Google and Facebook jointly as part of their taxation liability to the Government of India.

The possible problem that could arise in the taxation system of digital economy is that it might lead to impose double taxation on various digital businesses, being operates in multiple jurisdictions. This might leads to the violation of double taxation avoidance agreement (DTAA) executed between India and the home countries of the global tech companies. Furthermore, most often in the absence of such digital taxation system, the businesses are not accounting for tax liability in the remote jurisdiction or in the residence country, hence leads to the double non-taxation. Especially in the developing countries like India, proper taxation of revenues generates from the country and its resources plays crucial role in development of the economy. Hence, the focus should be on the development of the framework to regulate in order to get a ‘fair’ taxation from the revenues generated by such businesses.

Implication of recent developments

The followings are few of the recent tax amendments in India:

Equalisation Levy: In India, equalisation levy has been implemented in 2016, when it charged 6% on revenue generation for online services offering, earned by non-Indian resident from the Indian taxpayers carrying on business. Under this, the foreign companies now mandatorily required to obtain a PAN number to operate and file return in India. It covers selling of both goods and services by non-Indian resident personal or company to the Indian taxpayers or resident in general.

Significant Economic Presence (SEP): In India, the concept of SEP first introduced in 2018, whereas SEP has been announced to be implemented in May 2021 and comes in effect from Apr 2021. Under the SEP rules, those non-residents of India who are undertaking the financial transactions or business activities within Indian origin, which leads to the prescribed revenue or user-linked thresholds, will be deemed to have a taxable presence in Indian region based on the economic nexus.

Withholding tax on E-Commerce transactions: It is the income tax paid to the Indian government by the payers of the income rather than the recipient of the income. Hence, the tax is withheld and deducted from the income due to the recipient.

 The Equalization Levy in integration with the SEP rule and Withholding taxes are one of the coordinated efforts towards the reformed digital taxation model. The focus is in line to bring digital giants within the jurisdiction(s) of local taxation system. Now, the companies that are having digital presence but without permanent establishment in India, comes under the ambit of the Indian local taxation jurisdiction(s).

 Conclusion

 In light of the recent state across globe, the timing and requirement of the amendment of international taxation is of utmost importance. With the COVID-19 pandemic outbreak, the economies are going in strain to push the circulation of money and purchasing power which in turns seems rash to impose more taxes on businesses that are already struggling for the survival. Moreover, the world economies are in need of revenue generation while e-commerce is flourishing and out-performing in order to overcome the limitations for physical presence and corporate business models are drastically transforming from the conventional models to remote methods of work. Hence, It’s fair to state that the emerging digital business models immensely profiting from the current scenarios, to be taxed adequately in order to boost the tax revenue collections of the government(s).

For more information, please read my blog at TPCI

https://www.tpci.in/indiabusinesstrade/blogs/digital-economy-and-the-changing-landscape-of-taxation/